Wednesday, 11 February 2009

Becker and Murphy on the stimulus package

Given that the government has just announced that it will waste $500 million of taxpayers money on our very own stimulus package, it may have helped if John Key had read the recent Wall Street Journal article by Gary S. Becker, the 1992 Nobel economics laureate, a professor of economics at the University of Chicago and senior fellow at the Hoover Institution, and Kevin M. Murphy, a MacArthur Fellow, an economics professor at the University of Chicago and a senior fellow at the Hoover Institution, before making such an announcement.

Becker and Murphy make the obvious, to everyone but the government, point that There's No Stimulus Free Lunch: It's hard to spend wise and spend fast. Becker and Murphy ask the question
How much will the stimulus package moving in Congress really stimulate the economy?
This seems an important question. They look at the spending parts of the House and Senate bills -- over US$500 billion -- and assessed the quantitative effects of four basic factors.
  1. How much increase in Gross Domestic Product (GDP) can be expected from the stimulus package?
  2. The increased government spending in the stimulus package is supposed to be only temporary, until the economy returns to a full employment level, but probably won't be.
  3. The effects on consumers and businesses of the stimulus package depend not only on the stimulus to short-term GDP, but also on how valuable the spending is.
  4. There are no free lunches in spending, public or private.
On the first point they say:
So our conclusion is that the net stimulus to short-term GDP will not be zero, and will be positive, but the stimulus is likely to be modest in magnitude. Some economists have assumed that every $1 billion spent by the government through the stimulus package would raise short-term GDP by $1.5 billion. Or, in economics jargon, that the multiplier is 1.5.

That seems too optimistic given the nature of the spending programs being proposed. We believe a multiplier well below one seems much more likely.
About the second point they write:
The evidence of past expansions of government programs is just the opposite. Once created they tend to survive and grow over time, even when the increases initially were said to be temporary. The underlying reason for this is that interest groups develop around new and expanded programs, and they lobby to keep and expand those programs.

This implies that the spending programs in the stimulus package will continue to some extent after the economy has returned to full employment. The multiplier at that time will surely be much closer to zero. Looking several years ahead, then, the average stimulus from the expansion in government spending will be smaller, perhaps much smaller, than the short-term stimulus.
As Milton Friedman once put it "There is nothing more permanent then a temporary government program." On the third point Becker and Murphy say:
Whatever the merits of other government spending, the spending in this package is likely to have less value. A very large amount of money will be spent quickly over a two-year period: $500 billion amounts to about one-quarter of the total federal government annual spending of $2 trillion. It is extremely difficult for any group, private as well as public, to spend such a large sum wisely in a short period of time.

In addition, although politics play an important part in determining all government spending, political considerations are especially important in a spending package adopted quickly while the economy is reeling, and just after a popular president took office. Many Democrats saw the stimulus bill as a golden opportunity to enact spending items they've long desired. For this reason, various components of the package are unlikely to pass any reasonably stringent cost-benefit test.
Again, an example of the simple but important point that politics always overrides economics, no matter how bad the politics and how good the economics. As to the last point Becker and Murphy say:
The increased federal debt caused by this stimulus package has to be paid for eventually by higher taxes on households and businesses. Higher income and business taxes generally discourage effort and investments, and result in a larger social burden than the actual level of the tax revenue needed to finance the greater debt. The burden from higher taxes down the road has to be deducted both from any short-term stimulus provided by the spending program, and from its long-run effects on the economy.
These four points apply as much to New Zealand as they do to the US, so I would like to hear the government's reply to them. It is incumbent on both supporters, and opponents, of any stimulus package to evaluate each of these four factors. Has the government really done this? If so, what are their conclusions? If not, why not?


Matt Nolan said...

"Given that the government has just announced that it will waste $500 million of taxpayers money"

Supposedly they were going to waste this money at some point in the future anyway (it was all planned spending that has been moved forward) - at least they are doing it now when the price of these things is lower :P

Paul Walker said...

Matt: you may be right. But something tells me that the government will find other things to waste money on in the future, even if it isn't these particular projects.

Matt Nolan said...

Hi Paul,

The money the government wastes is still constrained by what it can legislate - implying that government waste partially indicates a preference by public for this waste to occur. If the government uses up projects now, there will be less they can push through later ...

Paul Walker said...

Matt: I fear you are right, the fact that government waste is occurring does indicates a preference by public for this waste. And why not? If the government will throw other people's money at you, why would you complain? But a lot of voters also think that free trade is a bad idea, do we really want to let them determine trade policy? The same is true with government spending, do we want people who like such spending determining the amount of spending that takes place? Bad politics will always win out over good economics. Isn't part of the job of the economist to point out the downside of bad politics?